Building a Believable Financial Forecast

Alex Henderson of KPMG speaks on using financial projections and other tools to understand the health of your business

[Currently being revised]

Alex Henderson, Partner of Transactions Services with KPMG

Today’s session is going to cover financial forecasts. Often, we see sellers who are selling to buyers, and buyers are looking for particular detail, particular clarify from financial forecasts.*

We’ll talk about some best practice forecasting…

These are some ideas I’ve been asked to cover… good for you, and most importantly, for your investors.. The first comment is strategic. You want to see them as linking in to the business. I talk to them about their business, and it’s very clear they understand their business. However, when we then come to look at the set of financial forecasts, we don’t see that link. WE don’t see the new strategies, new markets, etc. building up through the forecasts. That presents a problem for the investor*. It’s a great company, but the clarity, the numbers are not there… (!)

Just turning that knowledge into a set of numbers, a set of forecasts so that a third party can come along and say ok, I can see how this business is heading… etc. Senior input- for entrepreneurs… senior people will be involved. Linking in with a business as it is today. Revenue forecast as it is linked with the expenditure forecast. Forecasts are sometimes put together by two different people, etc. are there natural synergies that are going to come through, etc.?

The business has established itself… you know the margins you’re making, you know the costs, etc. but perhaps you’re moving into new markets, etc. the new customers might have a different cost space, etc. you need to show that in the forecasts. They need to see numbers.. and a model to fit with that. That’s important. Around the content of the forecast. Investors like to see financial forecasts on a business rival basis. What is actually driving my business? Is it the take of internet users in China? Working down from that. First of all, we can go test those assumptions. They should feel comfortable.. building that down so it all flows through. The next one is integrated. This is an accounting one. This is having your profit loss, your balance sheet, and your forecast linked together.* This may not sound critical, but something that … they will want to see.! When you’re talking about a revenue strategy, we can see…

Macroeconomic. * Maybe for smaller entrepreneur type business, the whole global macro business is not… just making sure your forecast is thought about… etc. you’re impact by steel prices, etc. key prices that are very macro driven. You haven’t thought about the impact of macro factors. Just to see if anyone … questions, anything around forecasting?

..Ok, moving on.

Getting into more detail. Timely.* When you are putting together forecasts, what buyers like to see is that you’ve incorporated the latest financial aspects* of your business – don’t use the wrong numbers; you want to go back to change that, maybe better, maybe worse. Don’t show them the original. Show them that the latest results up to September, etc. so that real time information… is in there. Even as the deal goes along, the forecast has to change. In those two months… factoring those in, it makes it feel much more real, much more real time* and the investor knows that you are aware… you get that warm feeling that you are on top of your business from the real point of view and also the financial point of view.** TIMELY and UP TO DATE

SCENARIOS. Investors like to run sensitivity analyses,* they like to feel that you’ve thought about that first. What if we don’t win that new customer. They like to feel that you, the business manager, has thought about that as well. That can be changing the assumptions. What happens when we lose that? Small impact on revenue, or a major impact? Make people comfortable, but you are thinking about the business, etc. You want numbers to demonstrate that.

For those of you who want to know more about financial forecasting.

QUESTION

What do you advise I choose? About the time horizon?

It will depend on the investor. We’d ultimately have something very clear to the end of 2010. Nine months of actual results, etc. and then a very detailed 2011 forecast, etc. in a very planned sort of way. What are we going to do? Target this customer, think he can do 10% etc. More assumption based, we don’t know if people win… macro drivers, internet business, etc. probably a five year forecast overall… a very detailed 2011-2010

QUESTION

How can I really forecast?

How to really build a believable forecast? For even two years.

What indicators?

That’s a very good question. Let’s start with those six months. I want to do a few general things. Use the word story… you have a story, I want to see your forecast mirroring that story. “Your business can never be bigger than your parking lot.”

Three different plans? Nope. Having different scenarios… you would need to be comfortable and clear what those scenarios meant. Clearly not every single person in China… here’s one with ten classrooms…

Use what’s happened so far to demonstrate your business model. – show that it works. It works, need to scale it up. Legal results from one classroom.

A way that you can demonstrate to investors that your business model works. * You’ve got some way to take an example. You have some kind of business, schools. Two of them are making money… general fixed costs in your business. Somewhere between a forecast and historic numbers. That will be enough to cover my general fixed costs. We still this quite often especially in startup companies. You can demonstrate that the model is working. If you keep doing that, you demonstrate that the business as a whole is working. It shows that you as a business owner can see the path.

QUESTION

From my POV, business plans are often irrational and not based on reality. Sometimes the investor does not really understand the reality. We have an industry that is saturated within China… the sheer size of it… the sheer monopolized nature of it… how do you suggest to make a business plan that is realistic, rational? How the investor truly can understand what is going on?

As a non-entrepreneur… they’ve got to have a strategy, they’ve got to have a way to…

Once you’ve decided that you’ve got a way to do that… what you need to show to investors… main company, there is this other angle, and to do that is very difficult. The planning behind it is easier. But it’s for the investor; they will want to see first of all some empirical numbers. A clear plan. Maybe, if I was an investor, I wouldn’t want to come in just based on that story. I would want to see some evidence. This is how I did it… we can build on it. Moving towards the cities. Most competitors are trying to come in at that perfect moment when there is still a lot of money to make, but you’ve done enough to show that it’s possible*.

AUDIENCE

Some of the plans that you hear… depends on what kind of industry you’re in. As it relates to China.. is there something.. getting some good market type data, etc.? And perhaps it should be an increased example. As an investor, how do you filter, how do you suggest to filter between the magical numbers and the actual numbers?

I think you’ve got to use various bits of market research… when you spend a bit of time dwelling into it… you can see why… rectified all the different data sources. You need to back that up with on the ground type interviews, etc. The great difficult thing about China is that it’s a massive country. It’s mixed in the way it’s developed. You can crack Beijing today, or Shanghai today. It’s not just a case of saying there’s 200 million, or 1.5 billion- what is coming up in the future as you saturate Beijing, etc.